The long and the short of
it

One of the best ways to lose
money in the stock market is to try to make a lot of money quickly.
This is because attempts to make a lot of money quickly will
lead to the taking of excessive risks. Stock market gamblers
-- people who place large bets on short-term outcomes and/or
high-risk situations -- might be very successful for a while
depending on the market environment in which they are operating
and how lucky they happen to be, but they are unlikely to keep
the money they make. Like all gamblers, stock market gamblers
have a subconscious desire to lose and will continue to push
their luck until it runs out. It is, however, possible to make
and KEEP a lot of money by a) understanding the secular trends
and keeping one's investment position in synch with these trends,
b) being patient (not trying to make a lot of money quickly),
and c) doing the opposite of the manic-depressive crowd (increasing
exposure to a long-term bull market when the crowd becomes depressed
and reducing exposure when it becomes manic).

One of today's clearest and
most important secular trends is the upward trend in the gold
sector of the stock market relative to the overall market. By
using the Dow Industrials Index to represent the overall stock
market and the Barrons Gold Mining Index (BGMI) to represent
the gold sector we've attempted to illustrate the situation on
the following chart. Notice that a 20-year downtrend in the Dow/BGMI
ratio ended in 1980 and that this secular bear market in the
Dow relative to the BGMI was followed by a secular bull market
in the Dow relative to the BGMI (a 20-year upward trend in the
Dow/BGMI ratio). Notice, as well, that the long-term trend clearly
changed again near the start of the current decade and that Dow/BGMI
is now about 5 years into a secular bear market (a long-term
upward trend in the gold sector relative to the broad stock market).
Secular trends always last at least 10 years and if past is prologue
then the current Dow/BGMI trend will last 20 years, so the gold
sector will be trending higher relative to the broad market for
at least another 5 years and potentially another 15 years.

Interestingly, although the
secular trend change that occurred near the beginning of this
decade is obvious on the below chart and is consistent with long-term
trends in inflation and stock market valuations, few people are
aware of it. This is not actually unusual, though, because it
is typically only during the last few years of a secular trend
that the public becomes a true believer in the trend. It is,
in fact, the public's 'falling in love' with a trend that inevitably
pushes valuations to extremes and sets the scene for the next
major trend change.

Two years of consolidation or two
years of topping?

The period since the beginning
of 2004 has been unusually frustrating because consistent trends
have been few and far between. The following weekly charts, for
instance, show that both the Dow Industrials Index and the AMEX
Gold BUGS Index (HUI) have moved back-and-forth within horizontal
ranges during this 22-month period and that both were higher
at the beginning of 2004 than they are today.

The patterns shown on the above
charts could represent either mid-cycle consolidations or top
formations. Actually, we think both possibilities are represented
with the Dow slowly rolling over prior to the start of the next
major downward leg in its secular bear market and the HUI immersed
in a drawn-out consolidation prior to the start of the next major
upward leg in its secular bull market. Looking at the situation
another way, we think the rallies in the Dow over the past two
years have provided investors with opportunities to exit at what
will prove to be high prices (relative to where the Dow is likely
to trade over the coming 12-18 months) whereas the declines in
the HUI have provided investors with opportunities to enter at
what will ultimately prove to be relatively low prices.

One of the main reasons why
these patterns are taking such a long time to play-out is that
the financial world has remained awash in liquidity. Some central
banks -- most notably the US Federal Reserve -- have adopted
a 'tightening' posture, but the monetary tightening has been
so gradual and so widely anticipated that its effects have been
muted up until now. Also, while the Fed has been slowly tightening
the monetary reins other central banks have been increasing the
slack by soaking up US debt using newly-printed currency. And
as if that wasn't enough, the downward pressure on consumer spending
that would normally have resulted from the much higher oil price
has been significantly reduced by the supportive effects of having
hundreds of billions of "petro-dollars" re-cycled into
global stock and bond markets. In other words, forces that would
normally be expected to bring about a reduction in liquidity
have, to a large extent, been countermanded.

We don't think it's wise to
bet on the notion that financial liquidity will remain abundant
for much longer, though, because the political time-window during
which the Fed must get all of its monetary tightening out of
the way extends for a maximum of only 3 more quarters. That is,
if the monetary tightening doesn't take its toll on the financial
markets within the next few months then the pace of the tightening
will have to accelerate.

Current Stock Market Situation

While the Dow's trading pattern
is open to interpretation -- it could be rolling over (our view)
or it could just be consolidating within the context of a longer-term
advance (the majority view) -- there is less ambiguity in the
following chart of the Bank Index (BKX). It looks like the BKX
is in the process of completing a major top.

With reference to the 3-year
weekly chart of the Dow Industrials Index included above, although
we anticipate an eventual downside breakout from the trading
range of the past two years we don't think that such a breakout
will occur this year. Instead, we expect that support at around
9800 will hold if it is tested within the next few weeks and
that any drop to near this intermediate-term support will be
followed by a decent rebound. There are a number of reasons for
this, such as: a) liquidity is still plentiful, b) short-term
sentiment indicators have recently hit 'oversold' extremes at
a time of the year when declines often end, and c) the NASDAQ100
Index has recently begun to show relative strength.

We plan to exit at least half
of our bearish positions if the aforementioned support is tested
over the coming weeks.
Steve Savilleemail: sas888_hk@yahoo.comHong Kong